Traps for the Unwary Executive or Founder When Offering Securities

February 23, 2021

By: Gil B. Selinger

I am very pleased to introduce my partner and Chair of our Corporate and Securities Departments, Gil Selinger. Gil is going to educate us on some important issues concerning soliciting investors for a company, an important issue for many C-Level executives who are often asked to assist in identifying investors, or who may be investors themselves.  

Executives of early and mid-stage growth companies are often tasked by their founders (if they are not one and the same person) to work towards raising capital to help their company grow. While seemingly merely a sales task, there are many traps for the unwary when trying to round up investors for a financing round. Below are five traps that can be easily navigated by awareness and knowing when it’s time to ask for help from a lawyer or other professional advisor. 

  1. Awareness of the Legal Landscape. Private offerings of securities in companies are governed by both federal and state securities laws. While it is not important for an executive or founder to become an expert on securities laws, knowing that they exist and that they need to be complied with is an important first step. The key is qualifying for certain exemptions under state and federal securities laws. The risks of noncompliance with securities laws are much more significant than noncompliance with some other laws. The penalties can include monetary damages or having to reimburse investors (a risk for both the Executive, the company and its owners), possible criminal penalties, and possibly being banned from the sale of securities in the future. All of these issues can be tackled by working with a lawyer to make proper disclosures, and to understand how, where, and to whom the offer should be made. It sounds complicated, but understanding a few guidelines will make it easy to comply with securities laws and enjoy the protection they provide to companies and their representatives. 
  2. Choose Your Investors Wisely. If you have reached the point of actually discussing an investment with potential investors, you certainly are anxious to get the funds in and use them. However, it is important to pause and consider who you want to have as partners with in the business you run or own. Once an investor is accepted and becomes part of the ownership, the relationship is not very easy to break. Having the right group of investors who are motivated and sophisticated will make managing the company easier. Consider that investors can bring more to the table than their dollars, such as strategic value or board leadership skills. It is important to give yourself enough time to find the right partners before jumping on the first offer of cash. Additionally, investors who have had problems in their background or otherwise have had issues in the securities world are investors best avoided if possible. All of this amounts to understanding that finding an investor is a two way street. The investor brings their money and other skills if and when they invest, but making sure they are the investor you need and want is also your job and should be equally weighed in the offering process. 
  3. Be Careful Advertising the Capital Raise. Posting on social media or taking out an ad may seem like a quick easy way to find investors, but this may inhibit the way you structure your offerings. While advertising (legal words: general solicitation, crowdfunding) is permissible under certain rules, it significantly constrains how you can offer the interests in your company and who can buy them. Before advertising far and wide, consider the pros and cons of these types of offerings and make sure they meet your goals in the context of complying with the rules.
  4. Choose Your Words Carefully. In the world of offerings of securities, overpromising or even promising at all are very dangerous. Whether it is in the context of a cocktail party where you meet a potential investor, in a formal pitch, or in written materials, it is important to use words such as “intend to”, “plan to,” and “try to” rather than “will”. Anything that can be viewed as an absolute statement without any equivocation, can later be used by an investor against you if the investment goes south. Qualifying your answers on the company’s plans and its attractiveness will protect you later. 
  5. Consider Carefully Before Using a “Finder”. There are entire bodies of law related to who can be compensated and how for finding investors for you. There are certainly ways to do it within the laws, but you should consider the associated fees as a sunk transaction costs. An executive or founder should carefully vet any broker/finder who would help them with the offering and confirm whether they are properly registered, or if they aren’t, consult with an attorney to see what the constraints are on paying an unregistered person to help you find money. The risk of using the wrong compensation model, or compensating the wrong person in the context of finding capital for your financing will be borne by the issuer (company), its representatives, as well as the finder. It behooves everyone to properly navigate these rules.

Understanding and evaluating these issues will get you well on your way to a legally sound and compliant securities offering by helping you understand the right rules to guide your words and actions in finding investors. Additional advice or questions about these issues can be answered by competent securities lawyers who are important partners in the offering process.

Subscriber to the C Level Law Blog here.